Restricting the trade universe

Options trading books for beginners typically follow a fairly well-worn path. Firstly, a call and a put option is explained. Then volatility is discected and the Black-Scholes model is discussed. Which leads perhaps to put-call parity and the greeks. Theory over, some multi-legged trades are considered. These have exotic names like “Iron Condor” and “Butterfly”. Armed with a few payoff disgrams, you are now ready to take on the world!

All this is fine but, if you are gonig to win in the ASX options market you need to focus on the key factors for success. One of these factors is “restricting the trading universe”. By this I mean ruling out what NOT to trade.

Australian options market

In comparison with the US market, the Australian market is defined by a few key factors:

  1. Trading and liquidity is concentrated in a few stocks e.g. XJO (the S&P/ASX 200 Index), BHP, the banks and Telstra. In comparison in the US there are many liquid symbols spanning different industries.  In addition to stock options there are also options on funds, commodites, FX and futures.
  2. When you trade, your counterpart is likely to be a market-maker. For a bit of explanation, “market-markers” are authorised by the ASX to quote buy and sell prices for options. They are obligated to quote prices for various strikes and expiries for a minium amount of time during the day. There is a higher probability of trading against a real person when trading in the US.
  3. Commissions are higher in Australia than in the US.

My trading guidelines

I suggest the following guidelines (with the proviso that its OK to break them with a good reason).

  1. Focus on liquid underlyings (e.g the name above). Spreads are typically tighter, which gives a fighting chance.
  2. Focus on the closest expiries (e.g. the next 3)
  3. Be careful with trades with three or more legs (e.g. condors and butterflies) esp if not on the XJO.
What I trade
  1. I exclusively trade XJO options with a heavy focus on the next 2 expiries which tend to be the most liquid.
  2. I am equally happy to be a buyer and a writer.
  3. I trade several strategies including straddles, strangles and unbalanced butterflies in addition to buying / writing single options.

Happy trading

Ed

Options Trading: Use an adviser or go it alone?

This is a fundamental point. I’ll present the arguments for both cases.

Use an adviser

There are a few very good reasons for using an ASX-accredited advisor:

  1. Trade Selection. An advisor will typically contact his clients periodically with trade recommendations. The quality of these recommendations can of course vary, but an experienced advisor is likely to come up with much better ideas than an inexperienced beginner. From a learning perspective, this can give the client a few ideas to focus on.
  2. Execution. Advisors can assist with placing orders into the market, which can itself be a little complicated for new traders (particularly if a trade has multiple “legs” i.e. two or more options are being simultaneously traded). Advisors who know their stuff will be aware of the nuances involved in getting the best price. Advisors will require clear instructions from the client but from there they take responsibility for any errors.
  3. Monitoring. Advisers will monitor the trade and recommend the optimimum time to close it to book profits or manage losses. In addition they can advise the client on managing their trades around dividends or corporate actions.
There are of course a few disadvantages of using an advisor. The most obvious is cost. Keep in mind that brokerage on options is typically higher than for shares. Use of an advisor increases the cost further.

Go it alone

An alternative is to use an online broker. The primary advantage of using an online broker is cost savings.  These savings can ultimately lead to a better bottom line, enabling better market timing (cost effectively scaling and out of trades) as well better risk mangement by cost-effectively hedging using additional options trades or stock. Discount brokers can also potentially offer research, information and portfolio analytics (e.g. calculate the option “greeks” for a particular position).
Disadvantage is obvious. You’re on your own.